Fitch Ratings has affirmed Element Fleet Management Corp.'s Long-Term Issuer Default Rating (IDR) at 'BBB+'.

The Rating Outlook is Stable. In addition, Fitch has affirmed Element Fleet's senior unsecured debt and senior unsecured credit facility ratings at 'BBB+'. Today's rating actions have been taken as part of a periodic peer review of fleet leasing companies, which is comprised of four publicly rated firms.

KEY RATING DRIVERS

IDR AND SENIOR DEBT

The rating affirmations reflect the firm's position as the largest pure-play fleet leasing and management company in the world, solid asset quality and minimal residual value risk in the portfolio, stable cash flow generation provided by leasing and services and the matched-funding strategy for assets and liabilities.

The ratings also reflect management's progress in executing its strategic, operational and financial plan. Efforts have included reducing Fitch-calculated leverage to the 8.0x-9.0x range, exiting non-core assets, including U.S. truck lessor 19th Capital Group, LLC, limiting customer attrition within its core fleet leasing business and returning to profitability, given incremental operational improvements and a growing syndication strategy that has improved revenue growth, while managing credit exposure to large clients.

Ratings are constrained by Element's relatively high use of financial leverage compared with other leasing companies rated by Fitch, still heavy reliance on secured, wholesale funding sources and Element's syndication activity to manage customer concentrations and to de-leverage, which remains in the early stages.

Fitch believes that the coronavirus will have a modest impact on Element's financial metrics over the medium term, notably asset growth and earnings. Fitch believes that customer-credit risks remain elevated as the continuation of social-distancing measures in the U.S., resulting from high coronavirus cases, could pressure Element's operating cash flow generation. However, Fitch believes the impact of these risks is manageable, even through renewed lockdowns given the essential business-use of the vehicles, investment grade customer profile, open-end lease structure, and limited contracted deferral activity to date.

Fitch's Global Economic Outlook (GEO), published Sept. 7, 2020, forecasts global GDP in 2020 to contract 4.4%; improved from a 4.6% contraction forecast in June, noting that the initial phase of economic recovery from coronavirus-related lockdowns has been faster than expected. Even though the coronavirus has yet to be contained, Fitch's base case assumption assumes that major advanced economies will avoid renewed national lockdowns, but economic activity will not fully return to pre-virus levels until 4Q21 in the U.S.

Over the last two years, management has executed a business transformation plan intended to improve customer experience, drive additional revenue opportunities, and enhance scale efficiencies and operating performance. The transformation plan includes initiatives to manage costs, reduce operating expenses and improve productivity. Of the CAD180 million in planned run-rate profitability improvement, management indicated they have actioned CAD166 million through June 30, 2020, and expect to complete the transformation by YE 2020. Fitch views Element's execution on the strategic transformation plan favorably, as it improves operating income and positions the company for future growth.

The strategy also includes a plan to drive revenue growth through broadening the use of lease syndication, thus creating a source of recurring fee revenue, while reducing balance sheet leverage and mitigating client concentrations. In 1H20, Element syndicated CAD1.6 billion of assets and generated CAD36.4 million of syndication fees, representing 7.7% of net revenue; relatively flat compared to CAD39.0 million of revenue (7.9% of net revenue) in 1H19. Fitch believes the level of syndication activity will depend on portfolio concentrations (client and asset mix as well as lease terms), availability of funding relative to securitizations and bank financing and balance sheet leverage. While Fitch believes Element's syndication activity brings benefits, it is still early days and has to be observed through a market cycle to make a full assessment of the reliability of market access and the stability of syndication revenue.

Asset quality for the core fleet leasing portfolio has been solid since inception, as evidenced by minimal impairments and charge-offs, given Element's focus on large corporate fleets where the clients have stronger credit profiles. Annualized impairments as a percentage of finance receivables amounted to 2.0% in 1H20, which was higher than the four-year average of 0.8% from 2016-2019, given growth in the receivables balance over 120 days past due from a number of struggling clients. Still, impairments do not generally result in credit losses for Element as historic net losses have averaged 0.01% from 2016-2019. This is because the majority of Element's lease portfolio is comprised of open-end leases, which are not subject to residual value risk. The essential business use of the vehicles leased by Element's clients also helps to mitigate the frequency and severity of lessee default. As a result, net losses have been minimal over time.

Element's profitability has been negatively impacted by losses related to the company's non-core operations in recent years, primarily from the investment in 19th Capital. However, on May 1, 2020, Element sold the assets of 19th Capital and settled third party debt at a discount, resulting in a pre-tax loss of CAD13.9 million. In 1H20, Element reported pre-tax earnings as a percentage of average assets of 1.8%, down modestly from 2.1%, yoy. The economic slowdown has only modestly impacted fleet usage, given the essential business-use of the vehicles, and clients continued to stay current on their leases, given their strong credit profiles. Payment deferrals have only been granted on a limited basis (approximately 1% of clients), with a total amount deferred of only approximately CAD23 million and an average deferral period of 3.1 months. As a result, operating performance has remained relatively stable in the current environment, which is expected to continue in the medium term. Fitch views Element's ability to maintain stable operating cash flow generation, and improve operating leverage favorably as it should improve the firm's earnings quality over time.

In its assessment of leverage, Fitch assigns 50% equity credit to Element's CAD680.4 million of preferred shares outstanding in accordance with the agency's 'Corporate Hybrids and Notching Criteria,' given the cumulative nature of the dividends and that cumulative coupons may not be settled using common equity. At June 30, 2020, the company's gross debt to tangible equity ratio, as calculated by Fitch, was 8.7x, down from 9.0x at YE 2019. The reduction in leverage has largely resulted from amortization of vehicle-backed debt, an increase in syndication activity and retained earnings growth. Management expects tangible leverage to be below 8.0x by YE 2020, on Fitch's measure, which would be viewed favorably.

Element is primarily funded by securitizations and a senior unsecured credit facility. In June 2020, the company completed its inaugural unsecured debt issuance, pricing USD400 million of 3.85%, notes due June 2025. The proceeds, along with cash on hand, were used to repay the company's CAD567 million of 4.25% convertible notes when they matured on June 30, 2020. The debt issuance is part of management's strengthening of the balance sheet and further diversification of access to cost-efficient funding. Element expects to be a programmatic issuer in the U.S. bond markets, while seeking to opportunistically retire its convertible notes and hybrid capital. Element recently announced its intention to redeem all of its outstanding 6.5% Class G preferred shares in September 2020, eliminating the firm's most expensive series of preferred shares. As of June 30, 2020, unsecured debt was 22.9% of total debt, which is within Fitch's 'bb' category funding, liquidity and coverage benchmark range of 10%-40% for finance and leasing companies with an operating environment score of 'a'. Fitch would view further increases in unsecured debt favorably, as it would improve Element's funding flexibility.

As of June 30, 2020, Element had adequate liquidity, with balance sheet cash of CAD63.7 million and available contingent liquidity comprised of CAD2.9 billion of committed capacity under its securitizations, subject to borrowing base requirements, and CAD1.8 billion under its senior unsecured credit facility. Additionally, client lease payments provide the company with a stable, predictable source of cash flow to meet its operational obligations. Element has no unsecured term maturities until CAD172.5 million of 4.25% convertible debentures come due in June 2024.

On Aug. 27, 2020, Element announced the planned departure of its current CFO, Vito Culmone. Mr. Culmone joined Element in mid-2018 as part of a leadership team chosen to help drive targets outlined in the firm's transformation plan. With the operational and financial transformation expected to be completed by YE 2020, he is expected to depart Element in early 2021 following the appointment of a successor. Element has retained an international search firm to identify a successor. Given the depth and experience of the senior management team, Fitch views Mr. Culmone's departure as neutral to Element's ratings.

The Stable Outlook reflects Fitch's expectation for the maintenance of solid asset quality performance in the portfolio, consistent operating cash generation, an improvement in earnings, continued economic access to the capital markets and syndication market through various market cycles, matched-funding of the company's assets and liabilities and appropriate leverage for the current rating category, consistent with Element's relatively diverse client base, low loss experience and limited residual value risk.

The equalization of the unsecured debt and senior unsecured credit facility with Element's Long-Term IDR reflects the firm's funding mix and the presence of a pool of unencumbered assets, which suggests average recovery prospects on the notes under a stress scenario.

RATING SENSITIVITIES

IDR AND SENIOR DEBT

Factors that could, individually or collectively, lead to negative rating action/downgrade include significant client departures that negatively affect lease revenues and ultimately core operating cash flow generation, a degradation in the company's competitive position, material increase in losses from client bankruptcies, outsized growth that exceeds internal capital generation or controls and/or a sustained increase in leverage above 9.0x.

Fitch believes the likelihood of a ratings upgrade over the medium term is limited given the challenging economic backdrop from the coronavirus pandemic and Element's higher than peer leverage. However, factors that could, individually or collectively, lead to positive rating action/upgrade include a reduction in tangible balance sheet leverage, as calculated by Fitch, to or below 6.5x on a sustained basis, improved profitability resulting from positive operating leverage and enhanced scale, stability in the syndication strategy and consistent, economic market access over time, an increase in unsecured funding above 40% of total funding and improved management stability.

The senior unsecured debt rating is equalized with the Long-Term IDR and would be expected to move in tandem. However, the senior unsecured debt rating could be notched down from the Long-Term IDR if the level of unencumbered assets decline significantly, thus reducing balance sheet flexibility.

Based in Toronto, Ontario, Element is the largest commercial fleet leasing and management company in North America. As of June 30, 2020, the company had over CAD16.9 billion in total assets. Element is publicly traded on the Toronto Stock Exchange under the ticker 'EFN'.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579]

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

The highest level of ESG credit relevance, if present, is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

RATING ACTIONS

ENTITY/DEBT	RATING		PRIOR
Element Fleet Management Corp.	LT IDR	BBB+ 	Affirmed		BBB+

senior unsecured

LT	BBB+ 	Affirmed		BBB+

VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

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